1. Cost Management ACCOUNTING AND CONTROL
HANSEN & MOWEN

2. CHAPTER 21
Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints

3. 1 Just-in-Case Inventory Management
OBJECTIVE 1
Three types of inventory costs can be readily identified with inventory:
The cost of acquiring inventory.
The cost of holding inventory.
The cost of not having inventory on hand when needed.

4. 1 Just-in-Case Inventory Management
OBJECTIVE 1
1. Ordering Costs: The costs of placing and receiving an order.
Examples: Clerical costs, documents, insurance for shipment, and unloading.
2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component.
Examples: Setup labor, lost income (from idled facilities), and test runs.

5. 1 Just-in-Case Inventory Management
OBJECTIVE 1
3. Stock-Out Costs: The costs of not having sufficient inventory.
Examples: Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production.
4. Carrying Costs: The costs of carrying inventory.
Examples: Insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory, and storage.

6. Traditional Reasons for Carrying Inventory
Just-in-Case Inventory Management
OBJECTIVE 1
Traditional Reasons for Carrying Inventory

7. 1 TC = PD/Q + CQ/2 Economic Order Quantity
Just-in-Case Inventory Management
OBJECTIVE 1
Economic Order Quantity
TC = PD/Q + CQ/2
The total ordering (or setup) and carrying cost
The cost of placing and receiving an order (or the cost of setting up a production run)
The known annual demand
The number of units ordered each time an order is placed (or the lot size for production)
The cost of carrying one unit of stock for one year

8. 1 An EOQ Illustration Just-in-Case Inventory Management EOQ =  2PD/C
OBJECTIVE 1
An EOQ Illustration
EOQ =  2PD/C
D = 25,000 units
Q = 500 units
P = $40 per order
C = $2 per unit
EOQ =  (2 x 25,000 x $40) / $2
EOQ =  1,000,000
EOQ = 1,000 units 8

9. When to Order or Produce
Just-in-Case Inventory Management
OBJECTIVE 1
When to Order or Produce
Reorder point = Rate of usage x Lead time
Example: Assume that the average rate of usage is 100 parts per day. Assume also that the lead time is 4 days. What is the reorder point?
Reorder point = 4 x 100 = 400 units
Thus, an order should be placed when inventory drops to 400 units.

10. Just-in-Case Inventory Management
OBJECTIVE 1
The Reorder Point

11. Demand Uncertainty and Reordering
Just-in-Case Inventory Management
OBJECTIVE 1
Demand Uncertainty and Reordering
To avoid running out of parts, organizations often choose to carry safety stock. Safety stock is extra inventory carried to serve as insurance against fluctuations in demand.
Example: If the maximum usage of the VCR part is 120 units per day, the average usage is 100 units per day, and the lead time is four days, the safety stock is 80.
Maximum usage 120
Average usage -100
Difference 20
Lead time x 4
Safety stock 80

12. EOQ and Reorder Point Illustrated
Just-in-Case Inventory Management
OBJECTIVE 1
EOQ and Reorder Point Illustrated

13. Setup and Carrying Costs: The JIT Approach
JIT Inventory Management
OBJECTIVE 2
Setup and Carrying Costs: The JIT Approach
JIT reduces the costs of acquiring inventory to insignificant levels by:
1. Drastically reducing setup time
2. Using long-term contracts for outside purchases
Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels.

14. Due-Date Performance: The JIT Solution
JIT Inventory Management
OBJECTIVE 2
Due-Date Performance: The JIT Solution
Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand.
Lead times are reduced by:
reducing setup times
improving quality
using cellular manufacturing

15. Avoidance of Shutdown: The JIT Approach
JIT Inventory Management
OBJECTIVE 2
Avoidance of Shutdown: The JIT Approach
Total preventive maintenance to reduce machine failures
Total quality control to reduce defective parts
The use of the Kanban system is also essential

16. What is the Kanban System?
JIT Inventory Management
OBJECTIVE 2
What is the Kanban System?
A card system is used to monitor work in process
A withdrawal Kanban
A production Kanban
A vendor Kanban
The Kanban system is responsible for ensuring that the necessary products are produced in the necessary quantities at the necessary time. 12

17. 2 JIT Inventory Management Withdrawal Kanban Production Kanban
OBJECTIVE 2
Withdrawal Kanban
Production Kanban

18. JIT Inventory Management
OBJECTIVE 2
Vendor Kanban

19. JIT Inventory Management
OBJECTIVE 2
The Kanban Process

20. 2 JIT Inventory Management
OBJECTIVE 2
Discounts and Price Increases: JIT Purchasing versus Holding Inventories
Careful vendor selection
Long-term contracts with vendors
Prices are stipulated (usually producing a significant savings)
Quality is stipulated
The number of orders placed are reduced

21. 2 JIT Limitations JIT Inventory Management
OBJECTIVE 2
JIT Limitations
Patience in implications is needed.
Time is required.
JIT may cause lost sales and stressed workers.
Production may be interrupted due to an absence of inventory.

22. Basic Concepts of Constrained Optimization
OBJECTIVE 3
Every firm faces limited resources and limited demand for each product.
External constraints, such as market demand
Internal constraints, such as machine or labor time availability
Constrained optimization is choosing the optimal mix given the constraints faced by the firm.

23. Total contribution margin
Basic Concepts of Constrained Optimization
OBJECTIVE 3
Linear Programming
The unit contribution margins are $300 and $600 for X and Y, respectively.
Z = $300X + $600 Y
Total contribution margin
This equation is called the objective function, the function to be optimized.

24. 3 Linear Programming Internal constraints: External constraints:
Basic Concepts of Constrained Optimization
OBJECTIVE 3
Linear Programming
Internal constraints:
X + Y  80
X + 3Y  120
2X + Y  90
External constraints:
X  60
Y  100

25. 3 Linear Programming Basic Concepts of Constrained Optimization
OBJECTIVE 3
Linear Programming
X + Y  80
X + 3Y  120
2X + Y  90
X  60
Y  100
X  0
Y  0

26. Basic Concepts of Constrained Optimization
OBJECTIVE 3
Graphical Solution
160
140
120
100 80 60 40 20
X  60
Y  100
2X + Y  90
X + Y  80 B C
X + 3Y  120 A D

27. C is the optimal solution!
Basic Concepts of Constrained Optimization
OBJECTIVE 3
Linear Programming
Corner Point X-Value Y-Value Z = $300X + $600Y
A 0 0 $
B ,000
C ,000
D ,500
C is the optimal solution!

28. 4 Three Measures of Systems Performance: Throughput Inventory
Theory of Constraints
OBJECTIVE 4
Three Measures of Systems Performance:
(Sales revenue – Unit-level variable expenses)/Time
Throughput
Inventory
Operating expenses 17

29. Five-Step Method for Improving Performance
Theory of Constraints
OBJECTIVE 4
Five-Step Method for Improving Performance
1. Identify an organization’s constraints.
2. Exploit the binding constraints.
3. Subordinate everything else to the decisions made in Step 2.
4. Elevate the organization’s binding constraints.
5. Repeat the process as a new constraint emerges to limit output. 18

30. Drum-Buffer-Rope System: General Description
Theory of Constraints
OBJECTIVE 4
Drum-Buffer-Rope System: General Description
Continued from left
Continued

31. Drum-Buffer-Rope System: Schaller Company
Theory of Constraints
OBJECTIVE 4
Drum-Buffer-Rope System: Schaller Company

32. New Constraint Set: Schaller Company
Theory of Constraints
OBJECTIVE 4
New Constraint Set: Schaller Company

33. End of Chapter 21